Early Warning Indicators Of Economic And Financial Instability Indexes

This paper is an empirical study which analyzes economic and financial instability periods. I composed two early warning indicators: one for a period of economic instability and other for a period of financial instability. The index of economic instability periods is called EWI (Economic Warning Index) and it is defined with the aid of an intermediary indicator CII – defined in terms of industrial production growth, external trade growth and unemployment growth – and of a basket of significant macoreconomic and financial variables. The index of financial instability period called FWI is defined through an intermediary indicator FII – expressed in terms of a benchmark rate used on the interbank market and of an index from capital market of each country in the panel. I defined a set of fourteen potential leading indicators either macroeconomic or financial, at monthly frequency, in the period January 2000 – December 2012. The countries included in the study are Czech Republic, Hungary and Romania. It was composed a balance panel with six thousand and eighty four observations. At the basis of my decision to choose a continuous model was the fact that it motivates policy makers in steering policy continuously and the fact that there is no need to decide between yes/no value of crisis. This research aim to observe which of the potential leading indicators used in the analysis are significant in explaining the incidence of economic and financial instability periods and give us a warning regardless any negative trends in the macroeconomic or financial activity, affecting the national or the global situation. There is both a quantitative and qualitative approach. Using econometrics technicques as OLS regressions, Fixed effects and Fixed dummy effects there were identfied significant indicators in explaining economic and financial instability periods. According to their ability of warning the signals are classified as late warning (less than one year), early warning (one to three years) and ultraearly warning (more than three years). The evaluation results suggest that between economic and financial environment it is a strong relationship and that there is a range of leading indicators which gave us a warning signal regarding any instability periods occurred in the economy.